Tuesday 11 December 2012

Income Tax Treaty between Canada and Hong Kong Special Administrative Region of the People’s Republic of China


This article was first published in the December, 2012 edition of Carswell TaxnetPro's publication Private Companies and Taxes.

On the 11th of November, 2012, the Government of Canada signed a tax treaty (“Treaty”) with Hong Kong.  The treaty will come into force the first day of January in the calendar year following the calendar year in which the treaty is ratified.  Hong Kong continues to enjoy a high degree of autonomy since its 1997 handover to China. Hong Kong is therefore not covered under the Canada – China tax treaty.  The Treaty as will be seen further in this article has more favorable withholding rates to that of the Canada – China Treaty.    The Treaty is similar to the tax treaties Hong Kong has entered to since 2009.  In 2009 Hong Kong was almost placed on the Grey List by members of the OECD as a jurisdiction that had committed to internationally agreed tax standards but had not implemented such standards.  The standard causing grief to the OECD members was “the exchange of information standard” based on Article 26 of the 2004 OECD Model Tax Treaty.  In order to avoid the possibility of being placed on the grey list which would have led to repercussions from member OECD states, Hong Kong was required to enter into 12 comprehensive income tax treaties so as to be regarded as a fully cooperating tax jurisdiction.  Hong Kong complied and has since 2009 entered into comprehensive tax treaties with more than 22 jurisdictions which include the Netherlands, Switzerland, China and Luxemburg.

All of Hong Kong’s tax treaties are based on the exchange of information standard contained in Article 26 of the 2004 OECD Model Treaty but deviate from Article 26 with the provision that the information exchanged must not be disclosed to any third jurisdiction for any purpose.  The exchange of information is only from the date the treaty is ratified and will not apply retroactively. 

The withholding tax rates in the Treaty are as following:
·        5% for dividends where at least 10% of the shares is held by the parent company;
·        10% for dividends paid in all other cases;
·        10% for interest charged between related parties – nil for interest between unrelated parties;
·        10% for royalty withholding.

However as Hong Kong does not have a withholding tax on dividends and interest, the focus of the rates is a reduction of the 25% rate imposed by the Income Tax Act on payments made from Canada to Hong Kong.  Currently the Canada – China Tax Treaty withholding rate is 10% for interest, dividends and royalties and as such the Hong Kong Treaty would be attractive to a Chinese corporation carrying on operations through a corporation in Canada.  However a careful read of the withholding provisions is mandatory to ensure compliance with the Treaty.

Although the Treaty does not contain a Limitation of Benefits clause the wording of a Limitation on Benefits clause is found in the royalty, interest and dividend articles.  This is seldom seen in treaties negotiated by Canada.  The purpose of a limitation of benefits clause is to ensure that a treaty is not used by an entity from a different jurisdiction that is not party to the treaty.    

For Canadian corporations carrying on business in Hong Kong through a corporation the Treaty will be good news as a Hong Kong corporation will qualify upon ratification of the treaty as a foreign affiliate situated in a designated treaty country.  This would allow dividends returning to Canada from the Hong Corporation’s active surplus to be exempt from tax in Canada. 

Sunita Doobay LL.B., LL.M., TEP, TaxChambers, Toronto

Friday 26 October 2012

Shareholder Control: Per Fiction or USA?

Recently published in the Canadian Tax Highlights a Canadian Tax Foundation Publication and reproduced with permission here.


A CCPC classification is attractive for a variety of tax reasons, including the preferential small business deduction and the heightened SRED investment tax credit (ITC) of 35 percent (rather than 20 percent). The decision in Bioartificial Gel Technologies Inc. (2012 CCI 120) is of particular significance, because the TCC in Bagtech concluded that a unanimous shareholder agreement (USA) resulted in CCPC classification although on the facts more than 50 percent of the corporation’s shares were held by non-residents. (The TCC in Ekamant Canada Inc. (2009 TCC 408) concluded that there was no USA on the facts in that case.)

Bagtech was incorporated under the CBCA and in 2004 and 2005 claimed the 35-percent SR&ED ITC rate as a CCPC. Non-residents held 62.52 and 70.42 percent respectively of its voting shares, but pursuant to a USA the actual right to elect the majority of the directors was held by Canadian residents.
The concept of control is central to the CCPC definition in section 127. The term control itself is not defined in the Act and thus the courts have been left to wrestle with its meaning. For purposes of a CCPC, control is subdivided into a de jure test (control in law) and a de facto test (control in fact). Whenever the Act refers to a corporation as being controlled “directly or indirectly in any manner whatever”, the de facto test for control is triggered: otherwise the only appropriate test of control is the de jure test. Due to the foreign ownership of Bagtech’s shares, the relevant provision to determine control was paragraph (b) of the CCPC definition in 125(7), which calls for the de jure test for control. 

When determining de jure control under paragraph (b) of the CCPC definition, it is important to note that that paragraph creates an important legal fiction: all the shares held by non-resident persons and public corporations are deemed to be owned by a single fictional person. If that fictional person is found to hold de jure control over the corporation, it does not qualify as a CCPC. In reality, the shareholders whose shares are held by the fictional shareholder may or may not act together to control the corporation, or even have any relationship with one another whatsoever. (See “Control Further Dissected”, Canadian Tax Highlights, April 2006.)

Generally, de jure control is “the right of control that rests in ownership of such a number of shares as carries with it the right to a majority of the votes in the election of the board of directors.” (Buckerfield’s Limited, 64 DTC 5301, [1964] CTC 504). Prior to the SCC decision in Duha Printers (98 DTC 6334, [1998] 3 CTC 303), the factors for determining whether de jure control existed included the corporation’s governing statute and its share register, and any limitation laid out in the constating documents on the majority shareholder’s power to control the election of the board or the board’s power to manage the business and affairs of the corporation. 

A USA allows shareholders, by a unanimous agreement, to limit or take away all of the managerial powers of the corporation’s directors and to grant those powers to all or some shareholders (as was the case in Bagtech). A run-of-the-mill shareholders agreement, which is solely contractual in nature, is distinct from a USA, which the SCC in Duha said was “a corporate law hybrid, part contractual and part constitutional in nature.” Significantly, a USA has the power to bind current and future shareholders.  Duha established that a USA should be treated as a constating document of a corporation in determining whether de jure control exists. The SCC said that in order for a majority shareholder to lose de jure control, the USA must not allow that shareholder “to exercise effective control over the affairs and fortunes of the corporation in a way analogous or equivalent to the power to elect the majority of the board of directors.”  

In Bagtech the minister contended that a USA does not apply to paragraph (b) of the CCPC definition in subsection 125(7) for purposes of determining whether de jure control is present: the text and the purpose of that provision would be frustrated if the fiction of control it creates could be watered down by a USA that allocates the powers of directors to a group of shareholders that never includes the fictional shareholder. The TCC in Bagtech disagreed and concluded that that provision’s fictional shareholder is bound by a USA. The TCC reasoned that the CCPC definition is a general provision and the court’s role is to give effect to its legislative intent: the legal fiction of a hypothetical shareholder applies in all situations and thus the fictional shareholder is bound by a USA in the same way that the actual shareholders are bound.

Bagtech crystallizes what was decided in Duha: a USA should be treated as a constating document when determining de jure control and in order to conclude that a non-resident majority shareholder does not have de jure control, the USA must remove that shareholder’s ability to control the corporation in a manner equivalent to the power to elect the majority of the board of directors. In addition Bagtech specifically concludes that a USA applies to a fictional shareholder created under paragraph (b) of the subsection 125(7) CCPC definition. Will the Act be amended in light of Bagtech, as it was following the decision in Silicon Graphics? The policy behind the CCPC definition and related provisions is to afford Canadian residents preferential tax treatment under the Act. Any legislative change, however, will likely await the result of the appeal to the FCA that was filed on May 14, 2012. 

Sunita Doobay
TaxChambers, Toronto

Rajeeve Thakur
Miller Canfield Paddock & Stone LLP, Toronto

Monday 3 September 2012

Austrian Private Foundation Not a Trust

Recently published in the Canadian Tax Highlights, a Canadian Tax Foundation publication and reproduced with permission here.


The FCA released its decision in Sommerer on July 13, 2012 (2012 FCA 207). The FCA dismissed the Crown's appeal, which challenged the TCC's conclusion (2011 TCC 212) on the application of subsection 75(2) and article XIII(5) of the Canada-Austria treaty.


In 1996, the father of Peter Sommerer (Mr. S), a Canadian resident, established a private foundation in Austria under the Austrian Private Foundations Act and capitalized the foundation with 1 million Austrian schillings of his own money for the benefit of Mr. S and his family. An Austrian private foundation may engage in investment activities that are consistent with its purposes, but it cannot engage in commercial activities; it is generally subject to the same income tax laws as other Austrian corporations but is exempt from Austrian income tax as long as it files an information return disclosing its beneficiaries. (A sale of corporate securities is tax-exempt in Austria if the sale occurs more than one year after acquisition.)


On October 4, 1996, Mr. S sold unconditionally to the foundation 1,770,000 shares of Vienna Systems Corporation for FMV at $1,177,050 and received $117,705 and a promise to pay the balance. In December 1997, the foundation sold 216,666 of the Vienna shares for $4.50 each to three individuals unrelated to the Sommerers, realizing a capital gain, and in December 1998 it sold the remainder to Nokia Corporation for $9.00 each, realizing a further capital gain. In April 1998, Mr. S sold unconditionally to the foundation 57,143 Cambrian Systems Corporation shares for $100,000. The foundation sold the shares to Northern Telecom in December 1998 for $14.97 each plus a further $4.12 per share conditional on certain milestones being met in 1999. That sale also resulted in a capital gain for the foundation.


The Canada-Austria tax treaty is based on the OECD model and provides that a gain from the sale of corporate shares is taxable only in the state where the seller resides: on the facts, the seller was the foundation based in Austria. The CRA sought to classify the foundation as a trust and argued that the trust's gains should be attributed to Mr. S pursuant to subsection 75(2) and thus brought within Canada's taxing jurisdiction. The CRA also argued that the treaty did not apply because Mr. S was a resident of Canada, not Austria.


The CRA failed to convince the TCC that the foundation should be characterized as a trust. The TCC said that the foundation was a corporation that held its property in trust for Mr. S and other beneficiaries. The TCC rejected the CRA's position that subsection 75(2) applied to Mr. S and concluded that that provision was intended to target a trust's settlor, who on the facts was the father, not Mr. S. The TCC said that the treaty overruled Canada's jurisdiction and established Austria as the taxing jurisdiction because both the father as settlor and the foundation/corporation as trustee were Austrian residents. Under the mind-and-management test, the TCC concluded that the corporation was an Austrian resident and that Mr. S did not exercise sufficient control to deem it to be a Canadian resident.


The Crown appealed to the FCA on the grounds that subsection 75(2) applied to Mr. S because (1) the TCC had concluded that the foundation held its property in trust for him and his family and (2) the proceeds from the sale were property substituted for the shares that he sold to the trust. The Crown argued that, for example, the proceeds of sale of the Vienna or Cambrian shares might one day be distributed to Mr. S, and thus he might receive property substituted (as defined in the Act) for the shares he had sold to the foundation. Attribution of the gain to Mr. S meant that the Canada-Austria treaty did not apply because he was a Canadian resident and the treaty protection extended to an Austrian resident only.


Mr. S disagreed with the TCC's conclusion that the foundation held its property in trust, but he chose not to argue the point and instead argued that subsection 75(2) did not apply to him and that the treaty would exempt him in any event. In obiter--the proposition was not the subject of submissions before the FCA--Sharlow J, writing for a unanimous FCA, concluded that it was doubtful that the foundation held its property in trust. She said that the foundation created under Austrian civil law resembled a corporation in Canada rather than a trust and that the rights of a member in a foundation resembled that of a shareholder in Canadian corporation:

Looking at the situation from another point of view, a shareholder or member of a corporation, as such, is not the beneficial owner of any property or the corporation, and has no legal or equitable claim to the corporate property (unless such a claim arises upon the declaration by the board of directors of a dividend, or when the dissolution of the corporation is imminent). Unless and until such an event occurs, a shareholder or member has only an inchoate right to receive distributions of corporate property from time to time at the discretion of the board of directors, and to share in the distribution of the corporate property upon its dissolution. The same can be said of the interest of a beneficiary or an ultimate beneficiary in the property of an Austrian private foundation. Nothing in the Austrian Private Foundations Act or the constating documents of the Sommerer Private Foundation gives Peter Sommerer a legal or equitable claim to the corporate property that is different from that of a shareholder or member of a corporation.
The fact that the father "as a practical matter . . . may well have achieved many of the objectives that could have been achieved in a common law jurisdiction by settling a trust" for Mr. S and his family did not mean that a trust was created at the foundation's establishment or when he sold the shares to it. Mr. S and his family more closely resembled a corporation's shareholders than a trust's beneficiaries with an equitable claim to the trust corpus. A foreign entity such as the foundation should be classified as a trust only if, under common law, a trust has been created. (Under common law, as summarized by the SCC in Air Canada v. M & L Travel Ltd. ([1993] 3 SCR 787), a trust is created only if three certainties exist: the intention to create a trust, the trust's subject matter, and the trust's object or beneficiary.) Sharlow J implicitly reflected the common law on the creation of a trust when she stated that "[a] corporation does not hold its property in trust for its shareholders or members, except to the extent that a trust deed or an analogous legal instrument imposes the legal and equitable obligations of a trustee on the corporation with respect to specific corporate property." She concluded that "[n]othing in the constating documents of the [foundation] or the law of Austria, as reflected in the record of this case, [supported] the conclusion that the right of the [foundation] to deal with its property is constrained by any legal or equitable obligations analogous to those of a common law trustee" or gave Mr. S a legal or equitable claim to the corporate property that was different from the claim of a shareholder or member of a corporation.


Although Sharlow J concluded that it was doubtful that the foundation held any property in trust for Mr. S, in the balance of her reasons she proceeded on the assumption--without deciding--that the father had settled a trust in favour of Mr. S and his family. In her analysis of subsection 75(2), she agreed with the TCC's Miller J that subsection 75(2) could not apply to a beneficiary of a trust who transfers property to a trust by means of a genuine sale and quoted his conclusion: "[O]nce properly unravelled and viewed grammatically and logically, the only interpretation is that only a settlor, or a subsequent contributor who could be seen as a settlor, can be 'the person' for purposes of subsection 75(2) of the Act." Sharlow J said that "to interpret subsection 75(2) so that it could apply to a beneficiary in respect of property that the trust acquired from the beneficiary in a bona fide sale transaction leads to outcomes that are absurd and could not have been intended by Parliament." The facts clearly showed that the foundation had purchased the Vienna shares with funds from the original endowment made by the father, who was not a resident of Canada, and thus subsection 75(2) did not apply.


Although that conclusion was sufficient to dismiss the appeal, Sharlow J commented on the Crown's treaty argument because the TCC had dealt with the issue. The Crown argued that the treaty provided no relief to Mr. S in the event that subsection 75(2) applied because he was not an Austrian resident. The Crown argued that the reservation under article XXXVIII(2), which allows Canada the right to tax residents of Canada on income and gains pursuant to section 91 (the FAPI rules), meant that the domestic attribution rules do not contravene a treaty that is based on the OECD model. If this argument had been successful, it would have created a groundbreaking precedent; but Sharlow J agreed with the TCC that "[t]here is no similar reservation relating to the attribution of income and gains under subsection 75(2), which means that Canada has not reserved the right to tax residents of Canada on income and gains attributed to them under subsection 75(2)." The FCA rejected the Crown's argument that foreign jurisprudence establishes that domestic attribution rules do not conflict with international tax conventions based on the OECD model. Instead, the court agreed with the international tax expert Karl Vogel that one must analyze each treaty and its reservation clauses before concluding that a specific domestic law overrides a treaty.


This is not the first time that the Crown has advanced the position that subsection 75(2) overrides a treaty's capital gains clause. In St. Michael Trust Corp. (sub nom. Garron Family Trust v. The Queen (2009 TCC 450)), the TCC discussed the interaction of subsection 75(2) and the relevant capital gains clause in article XIV(4) of the Canada-Barbados treaty. Woods J concluded that subsection 75(2) did not override that treaty's capital gains article, which was clearly drafted and reflected its object and spirit. She also said that the question to be asked was, "Did the Treaty's contracting states intend to reserve to themselves under Article XIV(4) a residual right to tax gains arising in the other contracting state?" and concluded that it did not: "I would also comment that the Treaty contains a specific override provision in reference to another attribution rule. Article XXX(2) provides an override in reference to the Canadian taxation of [FAPI] earned by non-resident corporations. If the drafters of the Treaty had intended an override for other attribution rules, they could have been specifically provided for it."


The issue of whether subsection 75(2) can override a treaty's capital gains article was first raised and rejected by the TCC in 2009. It was advanced by the minister in 2011 in Sommerer. It appears that the FCA has now settled the issue: subsection 75(2) does not override a treaty's capital gains article unless a clause in the treaty specifically carves out an exception for the application of subsection 75(2).


Sunita Doobay
TaxChambers, Toronto

Canadian Tax HighlightsVolume 20, Number 8, August 2012
©2012, Canadian Tax Foundation












Tuesday 7 August 2012

Contemporaneous SR & ED Documentation

Recently published in the Canadian Tax Highlights and reposted here with permission is the following article on the documentation requirement when claiming SR&ED:


The recent decision of the TCC in Murray Arlin Dentistry Professional Corporation v. The Queen (2012 TCC 133) was heard under the informal procedure and thus has no precedential value. Nonetheless, the decision is a reminder of the need to maintain contemporaneous documentation to evidence the fact that research was performed by the SR & ED claimant.

The taxpayer was a professional corporation operating the dental practice of Dr. A, a periodontist who specialized in implants. Dr. A spent at least one day a week studying data produced by specialized software that tracked the success rates of implants and the variables that affected those rates. Woods J accepted that the doctor’s research was a useful addition to scientific knowledge; at issue was whether for the 2007 and 2008 taxation years the doctor could prove that he spent an average of 350 hours per year systematically carrying out that research.

Woods J noted that SR & ED is defined in subsection 248(1) to mean a “systematic investigation or search that is carried out in a field of science or technology.” The TCC’s decision in Northwest Hydraulic Consultants Ltd. (1998 CanLII 553) remains the leading case on the meaning of “systematic investigation.” In that decision, Bowman J said that “[a]lthough the Income Tax Act and the Regulations do not say so explicitly, it seems self-evident that a detailed record of the hypotheses, tests and results be kept, and that it be kept as the work progresses.”


The facts in Murray Arlin show that Dr. A carried out research and that he did so on at least one day each week; but he never documented the hours spent, nor did he provide a hypothesis on what “uncertainty” he was overcoming with the data that he collected. Dr. A was a prolific writer, lecturer, and participant in study clubs. He used about 50 of the possible 200 software variables—such as whether the patient smoked and the type of implant—to track success rates. He had records for about 12,000 implants performed by him (approximately 1,000 surgeries a year). The CRA submitted that Dr. A “failed to develop specific hypotheses prior to the data collection” and that there was insufficient evidence of the time spent by him studying the data. Northwest Hydraulic analyzed the need for technical risk or uncertainty and the need for the claimant to “formulate hypotheses specifically aimed at reducing or eliminating that technological uncertainty.” Although Dr. A testified briefly that he updated his research for his lectures, many of the lectures were not given to implant specialists and they had a marketing component. The evidence was far too vague to establish the time spent on analysis or data collection and thus the one-fifth allocation of salary: the software was “designed to present comparative tables at the press of a button. The actual time spent on applied research potentially might be very small.”  Woods J agreed with the minister that without a hypothesis there could be no systematic investigation, but she was reluctant to agree that such a narrow position precluded a finding that there was insufficient evidence of systematic investigation. 

The major obstacle to ruling in the taxpayer’s favour was the lack of documentation: “The main problem that I have with the appellant’s position is that there was very little detailed evidence regarding the analysis done in the years at issue and the time spent.”

Sunita Doobay
TaxChambers, Toronto

Monday 9 July 2012

Art, Tax Shelters and Life


Art tax shelters bother me and they bother the Canada Revenue Agency  ("CRA") as well.  When I speak of art – I am speaking of visual art which includes prints, paintings and sculptures.  And this is the Art – Art tax shelters tend to focus on.

Art has always held a special place in my heart.  I grew up surrounded by Erwin De Vries’ paintings and sculptures.  Lately I have fallen in love with the works of Charles Pachter and that  of Carl Ray.  


Carl Ray was a contemporary of Norvelle Morriseau and a member of the Woodland Groupof Painters.  The other members of the Woodland group are Jackson Beardy, Eddy Cobiness, Alex Janvier, Daphne Odjig and Joe Sanchez.  The image to the left is a painting by Carl Ray - the copyright to the image belongs to the heirs of his estate.
 
Art tax shelters bother me because it cheapens the inherent value of art – art in a shelter becomes a means to a tax credit instead of a purchase to enjoy.  Art triggers various emotions – Van Gogh’sbales of hay is a beauty to behold and so is Monet’s.  Not sure why I love bales of hay but I do. TheScream by Edvard Munch always raises my anxiety level but not sure if it does the same for the recent purchaser of The Scream who paid $120 million U.S.  And I love Carl Ray`s usage of colours in the attached painting of the Loon and fish swirling around.

An art tax shelter is where you purchase a work of art below fair market value and then donate such work for fair market value to a charitable organization in exchange for a donation receipt thereby allowing you a credit at fair market value.  However how does one determine fair market value – this is rather a subjective test as endless of discussions on the Internet have demonstrated regarding the recent purchase price of The Scream.  The subjectiveness on the determination of fair market value also allows the CRA to challenge the valuation allocated to the work of art in a shelter arrangement.  
 
To the lover of Art - do note Dear Reader that the Canadian Income Tax Act allows a deduction against business income on the purchase of Canadian Art (print, sculpture and paintings).  A taxpayer is allowed to deduct under the capital cost allowance rules (depreciation rules) the cost of the Canadian art over a period of years against business income earned until the full purchase price has been deducted.

Art tax shelters were common but have mostly been shut down especially with the introduction of proposed subsection 248(35) which states that the cost of a gift is determined by the lesser of the amount paid (cost) or the fair market value of the gift.  However a discussion of art tax shelters is relevant though because other shelters have taken their place.  


In a shelter scenario the taxpayer does not win as illustrated in Klotz v.The Queen, 58 DTC 2236; [2004] 2 CTC 2892 even where such taxpayer relied on legal opinions from large law firms and on the opinion of their accountants.  In Klotz the taxpayer participated in an art flip program marketed by AFE Consultants Limited.  The taxpayer purchased prints and donated the prints to charities in return for a donation receipt.  The donation receipts displayed the market value of the prints to be several times more than what the taxpayers paid.  Tax opinions from large lawfirms confirmed that a tax credit could be claimed for the amount displayed on the receipts.  AFE Consultants Limited also paid a commission to accountants and other tax advisors who recommended the purchase of an AFE print to their client. 

The taxpayers in Klotz were audited by Canada Revenue Agency and were disallowed the credit claimed on the receipts.  The Tax Court of Canada and the Federal Court of Appeal agreed with Canada Revenue Agency but did allow the taxpayer a credit for the cost of the Art not the fair market value.  This was bad news for the taxpayer as they were out of pocket for the credit taken against their income which was twice or more than twice the value of the cost of the art.  Also back taxes, penalties plus interest had to be paid.

The reason for writing this post is that often taxpayers who get involved with tax shelters tend to be individuals of high net worth.  It was to my shock on Friday that I had a consultation as a favour to an acquaintance and learned that these donations shelters are not limited to the very well off but also to the lower income taxpayer such as the single mother I met with.  This single mother works shifts starting very early –  she raised her children on a very small income and heard through her tax preparer about how you could donate $4,000 to a religious organization and receive a $40,000 donation receipt in return.  The shelter came with promotional material and looked legit.  So she donated $4,000 – received her credit and continued to do so for the next few years.  Canada Revenue Agency in an audit discovered this shelter and seized the books and records of the promotor which led to the audit of this poor woman.  Her credits against income were denied and she now faces a tax bill of over $120,000 which includes penalties and interest and taxes owing.  It saddened me to see first-hand an unsophisticated taxpayer getting involved in a fraudulent scheme.  Such taxpayers rarely have access to an accountant or a tax advisor to warn them of the mine field of tax shelters.  Of course she should have known better but it is easy to also see her believing the fancy promotional material waved before her face and the lure of a large credit. 

One of the taxpayers (see Lemberg v. Perris, 2010 ONSC 3690 (CanLII))
 who took part in the 
AFE Consultants Limited shelter successfully sued his accountant for recommending the shelter on the basis that the accountant had breached the accountant – client fiduciary duty owed by an accountant to his or her client.  In Lemberg the accountant was paid a commission by AFE Consultants for recommending the purchase of the prints through the AFE shelter.  


However practically speaking law suits are expensive and if bringing a suit against the promoter of the shelter or the advisor recommending the shelter then one must also ensure that the statute of limitation for bringing such an action has not expired.  For a taxpayer caught in the web of tax shelters, recourse against the promotor, advisor can only happen through a class action law suit - it would be too expensive otherwise - for sure the single mother I met could never afford a suit on her own which in essence illustrates the difficulty of access to fairness for the lesser well off.

Friday 22 June 2012

IBC – A gateway for Canadian Corporations to the Caricom


The following will be published by Carswell in newsletter Privately Held Companies & Taxes and is reproduced here with permission.  I thought it would be of interest to readers expanding operations into the Caribbean. 


On November 8, 2011 the protocol to Barbados – Canada Income Tax Treaty was signed but has not been ratified by Canada as yet.  It is expected to be ratified this year.  The protocol now specifically addresses the IBC entity which was previously carved out of the treaty.  The Barbados – Canada Income Tax Treaty (“Treaty”) came into force in 1980.  The fact that the Treaty was so old meant that an IBC had to rely on the provisions of Regulation 5907(11.2) (c) of the Canadian Income Tax Act (“ITA”) in order to qualify as a foreign affiliate. (Regulation 5907(11.2)(c) provides that where a foreign entity has been carved out of a treaty signed prior to 1994 and where such treaty  has not been amended since but where  such foreign entity would qualify as a resident under the treaty in force then such foreign entity is accorded foreign affiliate status for the purposes of the ITA.  The IBC has always been an attractive entity for tax planning as it is subject to a maximum tax rate in Barbados of 2.5%.  Furthermore no withholding tax is levied on dividends and interest payments made by an IBC to another IBC or to a non-resident of Barbados. 

The protocol now extends treaty benefits to the IBC   but it should be noted that not all the provisions of the treaty apply to an IBC.  Specifically, Articles VI to XXIV do not apply to IBCs.  Consequently,  an IBC will not be able to benefit from the preferred treaty rates applied to payments in the form of dividends, royalties or interest derived from Canada and will be subject to a 25% withholding tax under the ITA.  The Protocol amends the residency determination provision (“the tie-breaker test”) to provide that where a company is deemed to be a resident of both Canada and Barbados, it will be deemed a resident of the country of which it is a national.  This amendment will  greatly reduce the difficulty of determining residency of an IBC for the purposes of Treaty.  Article IV of the 1980 Treaty refers to place of management as a criterion in determining residency of a corporation.  Garron (2012 SCC 14 (CanLII) however provides an illustration of the difficulty in determining place of management. 

The IBC provides a valuable gateway for Canadian business to access the Caricom markets.   Caricom is a free trade zone for countries in the Caribbean.  The Caricom now consists of 15 member countries including countries such as Suriname and Jamaica where Canadian companies are carrying out active mining activities.  An IBC structured correctly to meet the foreign affiliate definition of the ITA and the active business requirement will be able to distribute from its exempt surplus, consisting of active business income earned in certain Caricom  countries, dividends that will be received free from Canadian Income Tax by its Canadian corporate shareholders.  Under the Jamaica – Canada Income Tax Treaty, dividends paid from a Jamaican foreign affiliate to its Canadian corporate shareholder are subject to a Jamaican withholding tax rate of  22.5%.  Dividends paid from a Jamaican subsidiary to its Barbados shareholder is not subject to a Jamaican withholding tax under the Caricom double taxation agreement (“the Caricom Agreement”).  As the Caricom Agreement does not contain a limitation on benefits (“LOB”) clause, there are no barriers to utilising an IBC that is compliant with the foreign affiliate provisions of the ITA and the residency requirement of the Treaty for structuring investments into Caricom taking advantage of Barbados’s  position as a signatory to the Caricom Agreement Similar planning opportunities are also available under Barbados’s wide treaty network where the LOB clause is not present.

Ben Arrindell – International Tax Advisor, Bridgetown, Barbados.
Ben is an international tax consultant based in Barbados.  He is an advisor to the government of Barbados on international matters.  He has been a member of the Barbados government’s double taxation and bilateral investment protection treaty negotiation team since 1995 and has been a member of the United Nations Group of Experts on International Cooperation in Tax Managers for the past six years.  He is a former managing partner and international tax partner with Ernst & Young Barbados.

Sunita Doobay TaxChambers Toronto
Sunita Doobay’s tax law practice covers the full range of income taxation and income tax related matters with a primary focus on corporate tax. With a tax law background that spans over 20 years, she has provided tax advice on domestic and international tax issues to public and privately held companies.

Saturday 9 June 2012

R&D funding for collaborative Brazil-Canada projects




I am not sure why but when I think of Brazil and research I always think of Alberto Santo Dumont maybe because I adore the watch Cartier made for him and named after him.  For those of us who love watches, we have Alberto Santo Dumont to thank for the popularity of the wristwatch.   No, I am not going to go into the debate of who was the first inventor of the airplane the Wrights brothers or Santo Dumont ... However I do hope that we see many innovative projects resulting from the collaboration between Brazil and Canada  especially now through the new ISTPCanada program.

An often overlooked program for companies seeking bi-lateral research and development is the International Science and TechnologyPartnerships Inc. (“ISTPCanada”) has now launched an R&D collaboration program between Canada and Brazil.  This program is mandated by the Federal Government of Canada through Foreign Affairs and International Trade Canada (DFAIT) and provides an opportunity for a Canadian business to enhance its R&D with counterparts in Brazil.  Canada will provide up to $400,000 to Canadian company qualifying under the program.  It should be noted that this amount need not be repayable at the completion of the project.  If the Canadian entity is a Canadian university then the National Sciences and Engineering Council of Canada (“NSERC”) will award funding directly.  Under the Brazilian program, the Brazilian company will receive funding from the State it is carrying on research.


Should there be a judicially-created due diligence defence on the reporting of significant foreign property?

The following was co-authored with Darcy MacPherson and is published on TaxnetPro.  The article discusses whether a taxpayer can claim a due diligence defence for the failure to file Form T1135 - Foreign Income Verification Statement.  We argue no.  


            INTRODUCTION

 Since 1997 subsection 233.3(3) of the Income Tax Act[1](“Act”) mandates that Canadian resident taxpayers are required to file Form T1135 - Foreign Income Verification Statement - with their income tax returns where such taxpayers own specified foreign property with a cost amount of 100,000[2] or more.  Form T1135 is not required where the foreign property is personal property such as vacation property used by the taxpayer or personal property such as work of art, jewelry, rare books, stamps and coins. Failure to file Form T1135 will subject the taxpayer to a penalty of $25 a day up to a maximum of 100 days pursuant to subsection 162(7) of the Act.   There is no indication on the language of the statute that there is a defence of due diligence available when a taxpayer is late in filing this form.  Yet, in a recent case, Tax Court Judge Woods has clearly decided that the judiciary has the final say on the application of penalties.

In the view of the authors, there are problems with such an interpretation, on at least four levels.  First, as a matter as interpretation of taxing statutes, it is said that the taxpayer is always free to order his or her affairs so as to avoid liability to tax.  Thus, where a taxpayer does not do so, it lies ill in the mouth of the taxpayer to cry foul after litigation has commenced.  Second, as a matter of stare decisis, the case does not address other cases that have confronted the issue.  Third, as a factual matter, it is difficult to say how due diligence can be made on the facts of the particular case, or more generally.  Fourth, there are legitimate reasons that explain why a strict interpretation – meaning that the due diligence defence is unavailable in the case of a deliberate non-filing of the form –  is preferable, from a policy perspective.

I           THE FACTS

            In Douglas v. The Queen, 2012 TCC 73, a penalty was assessed against the taxpayer for the failure to file a form T1135 with respect to the 2008 tax year.  It is agreed that the tax return (and thus the form) was due on June 15, 2009, and was not filed until March 2010 (para. 5).  This is over 100 days late.  Therefore, the maximum penalty of $2,500 was imposed.  The taxpayer appealed, and represented himself. Under the informal appeal procedure, he claimed to have been duly diligent, and that therefore, the imposition of the penalty should be overturned.  The court agreed with the taxpayer.  The most directly relevant portion of the judgment (although we will refer to other portions further below) is as follows:

[14]         Although the penalty in subsection 162(7) is strict and Parliament has not provided for a due diligence defence, this Court has held that even strict penalties should not be applied if a taxpayer has taken all reasonable measures to comply with the legislation: Home Depot of Canada Inc. v. The Queen, 2009 TCC 281.

            In other words, the Court found that the actions of the taxpayer meant that it was appropriate to “read in” a due diligence defence where Parliament has not provided an explicit one.  Furthermore, the due diligence was not merely a theoretical possibility.  Mr. Douglas was entitled to use it on these facts.  As Her Honour puts it (at para. 17)

[17]         It has been my view that the judge-made due diligence defence should be applied sparingly. However, this is an appropriate case in which it should be applied.

While Tax Court Judge Woods claims that the defence should be “applied sparingly”, there is little to distinguish the facts of this case from that of those of many others.  For example, the Court says that it is “common knowledge in Canada” that a tax return can be filed late without negative consequences to the taxpayer if no tax is payable, by virtue of subsection 162(1) of the Act (para. 11).  The T1135 form says that the form is be filed with one’s tax return (para. 12).  To expect professional advice to be sought in these circumstances would not have been reasonable (para. 16).  The logic of Her Honour seems to be that the imposition of the penalty is inequitable, and that this inequity should not be visited upon the taxpayer.

II         ANALYSIS

A.                 Interpretation

Since 1935, it has been a basic principle of English and Canadian tax law that a taxpayer may organize his or her affairs in a way that seeks to avoid the application of tax.  See I.R.C. v. Duke of Westminster, [1936] A.C. 1.  From the point of view of the authors, the necessary corollary to this principle is that, if a taxpayer organizes his or her affairs in such a way that he or she is obligated by the rules to greater tax, or to make payments or other remittances to the government at a particular time, the taxpayer should be in no position to complain that had he or she organized his or her affairs in a different way, he or she would not have ben liable to these obligations.

This principle has been recognized by the drafters of the GAAR provision of the Act.  According to the Explanatory Notes to the GAAR provision subsection 245(3), Parliament recognized the Duke of Westminster principle that tax planning with the objective of attracting the least possible tax is a legitimate and accepted part of Canadian tax law.[3]


On the facts of Douglas, this would seem to suggest that since the taxpayer “made his bed” by not filing on time, he should not be allowed to avoid “lying in it”, that is, by paying the penalty.

B.                 Stare Decisis

1.                  General

Under the informal procedure, used in the Douglas case, the decision of the Tax Court Judge has no precedential value[4].  Therefore, it is clear that the Douglas case is not precedent-setting for future cases.  However, this is not the end of the issue of stare decisis.  Just because the Douglas case has no precedential value in future case cannot be read to allow the judge in Douglas to ignore prior cases.

It is virtually beyond debate that stare decisis has two components.  The first is horizontal stare decisis; the second is vertical stare decisis.  In terms of vertical stare decisis, this is the basic rule that a lower court is bound to follow the decisions of any court that is directly above it in the judicial hierarchy.  However, as far as the authors can tell, there are no higher court decisions that specifically contradict the holding in Douglas.  Therefore, vertical stare decisis is not really at play here.[5]

Horizontal stare decisis, on the other hand, is a critical component of this discussion. This element essentially holds that the Court as an institution should be relatively consistent in its application of the law.  In other words, one member of a court should not lightly depart from a precedent established by another member of the same court.  The authors have already written on this topic, in discussing the case of The Queen v. John H. Craig, a case with respect to which an appeal was heard by the Supreme Court of Canada on March 23, 2012.  There is no need to repeat ourselves.[6]    Below, we discuss both some recent case law dealing with the application of subsection 162(7) of the Income Tax Act, and the case of Home Depot Canada, on which Tax Court Judge Woods relies in reaching her decision.  In the view of the authors, the doctrine of stare decisis does not necessarily mean that there can be no change in the law.  However, in the Douglas decision, Her Honour paid insufficient attention to stare decisis in focussing her attention on the Home Depot case.

2.                  The Case Law

a.                   The Case Law on Point

                                                                                                   i.                  Asper

Tax Court Judge Woods was not without guidance on the proper interpretation of subsection 162(7) of the Income Tax Act.  In Leonard Asper Holdings Inc. v. Canada (Attorney General)[7] , a group of companies had not filed the required form, based on the belief that since the income from foreign property had been earned through Canadian money managers was to be reported to the taxing authorities by the money manager.  Therefore, the reasoning of the taxpayer was that Form T1135 did not need to be filed.  The Canada Revenue Agency disagreed, and assessed the penalty.  The case proceeded as a judicial review of the decision of an Agency official’s refusal of taxpayer relief, under an administrative program then in place at the Agency.  Just like in Douglas, the applicant taxpayer claimed confusion.  As the Court explains (at paras. 24-25):

The Applicant also submitted that the decision not to file the T1135 forms was the result of confusion. It cited guidelines on penalties associated with failure to file T1135 forms:

"No penalty will be assessed where it appears there was confusion concerning obligations and it is the first time a penalty is considered."

The Applicant submitted that if there was confusion with respect to the rules, then the CRA should have been more lenient about penalties. At the very minimum, the CRA should have accepted that the Applicant's representative was interpreting the rules in good faith, relying on accurate and timely reports being made to the CRA by money managers. It wrote: "The conclusion was wrong, but that does not detract from the reasonableness of the belief that the forms did not have to be filed."

Justice Mandamin responds to this argument as follows (at para. 40):

In my view, the Minister's delegate's reasons responded to the facts before him. He characterized the decision as a conscious decision by the Applicant's representative or the Applicant, one that was lacking due diligence rather than confusion. I find the reasoning draws a conclusion that was within the range of possible outcomes defensible on the facts. Moreover, since section 220(3.1) of the does not obligate the Minister to provide relief, the decision was clearly defensible in respect of the law as well as the facts.

Therefore, even though there was a specific program in place at the time to provide relief in appropriate circumstances, the Court indicated that the “confusion” on the part of the taxpayer was not attributable to a lack of clarity by the taxing authorities.  Rather, it was due to a lack of diligence by the taxpayer in fulfilling its obligations. 
It must be acknowledged that in Asper, the Court was engaged in a substantive review of the decision of an official (the “Minister’s delegate”) in an administrative-law context.  Also, the Court was reviewing the decision on a standard of reasonableness.  However, if the law demanded a due diligence defence on these facts, and the Minister’s delegate failed to even consider this issue, the authors would argue that the decision of the Minister’s delegate would have been unreasonable.  Given the result of the case, therefore, the sole conclusion to be drawn is that the due diligence defence is not available on these facts.  Therefore, given the similarity between the facts of this case and those presented in Douglas, if the due diligence defence was not available in Asper, there is little to distinguish Douglas and thus the same result should follow in the subsequent case.

                                                                                                 ii.                  Leclerc

The facts of Leclerc v. Canada, 2010 TCC 99 are even more similar to the Douglas case.  In Leclerc, the taxpayer has an expensive condominium in France, and did not report this in two non-consecutive years (2003 and 2006).  More accurately, because the taxpayer did not file his tax returns on time, the Forms T1135 for those years were also filed late.  From his other tax returns, the government knew that the taxpayer had this property (para. 12).  Though other factors were alleged to have contributed to his late filing, notably his studies and mental illness of his mother (see para. 9), Tax Court Judge Favreau upheld the imposition of the penalty.  This is also despite the fact that the administrative program that would have provided relief to the taxpayer had been withdrawn earlier by the taxing authorities, without notice to the taxpayer, even though the Agency knew that the change would affect him (para. 11).  As in Douglas, the total penalty was significantly higher than the total tax payable by the taxpayer for the years in issue (para. 13).  Nonetheless, the penalty was found to be appropriate.
In the end, therefore, the courts that had considered this issue prior to the Douglas decision found that the due diligence defence (even if there were one) had no application on facts similar to those before Tax Court Judge Woods.

b.                  The Home Depot Case

Interestingly, Tax Court Judge Woods does not even refers to either Asper or Leclerc.  Instead, Her Honour chooses to rely on the case of Home Depot of Canada Inc. v. Canada[8], a decision of Tax Court Judge Miller.  In this case, Deloitte Tax LLP was a company hired by the taxpayer to make its tax returns and other tax remittances, including the remittance of Goods and Services Tax collected pursuant to the Excise Tax Act, RSC 1985 c E15.  The remittance was sent to the wrong address by Deloitte.  The taxing authorities sought to impose a penalty for the lateness of the remittance. 
Tax Court Judge Miller writes as follows, with respect to the due diligence defence (at para. 12)

Can Home Depot avail itself of the due diligence defence? The Respondent argues that the jurisprudence relating to the development of the due diligence defence in tax matters supports a narrow, restrictive use of the term. The Respondent relies in large measure on comments of the Federal Court of Appeal in the 1998 decision of Canada (Attorney General) v. Consolidated Canadian Contractors Inc., to the effect that the defence is available in situations of uncertainty as to the correct amount to be paid on a timely basis. This approach appears to have been captured in the Government's Policy Statement P-237 dated July 28, 2008, which states:

Making a determination of due diligence
...
The CRA may accept a due diligence defence in a situation where a person remits or pays an amount that is less than the amount actually owed where that amount was arrived at after having made an incorrect assumption based on genuine uncertainty regarding the application of the ETA. In addition, in a situation where a person is a recipient who fails to report and remit the tax on a self-assessment situation and this failure can be attributed to an incorrect assumption based on genuine uncertainty over the application of the ETA, a due diligence defence may be accepted by the CRA. Also, the CRA may accept a due diligence defence where a person believed on reasonable grounds in a non-existent fact situation, which if it had existed, would have made the person's actions or omission innocent; that is, the person relied on a reasonable but erroneous belief in a fact situation. In any case, for a person to be duly diligent it must be clearly evident that despite making an incorrect assumption, or having an erroneous belief in a fact situation, all reasonable care has been taken to the best of the person's ability in ensuring that the correct amount was remitted or paid, and the return filed, when required.

Limitations on the application of due diligence
...
Late payment or remittance
The CRA would not generally accept a due diligence defence where the correct amount was paid or remitted after the due date. In particular, where the CRA determines that a person has complied with the obligation to collect the correct amount as required but has failed to remit this amount when required, the person's due diligence defence would not be accepted. It is the CRA's position that a person who has failed to take reasonable care to ensure that the correct amount was paid or remitted by its due date, has not exercised due diligence.

In Home Depot, the taxing authorities themselves had produced guidelines indicating that when a late remittance occurred notwithstanding the due diligence of the taxpayer, the penalty for such a late remittance would not be imposed.  These same guidelines continue on to explain what would be considered “due diligence” for the purposes of these guidelines, as well as what would generally not qualify.  With all due respect to Her Honour, this is in sharp distinction to the facts of Douglas.  There was no specific guidelines for a finding of due diligence mentioned in any of the cases involving the application of subsection 162(7).  Furthermore, in Home Depot, there was a genuine attempt on the part of the taxpayer at issue to comply with the requirements of the relevant statute on time.  In Douglas, the belief was not that he was making a genuine attempt to comply, but rather, the error was that the taxpayer believed that non-compliance would attract no negative consequences.  The authors discuss this issue in greater detail in the section immediately below.  For current purposes, however, it is sufficient to note the following. Home Depot arose under a different statute, with non-statutory guidance provided by governmental authorities (that the due diligence defence was potentially available, and the circumstances under which the defence was likely to be successfully invoked), and with a very different factual scenario (in that there was a genuine attempt by the taxpayer to comply with the statutory requirements).  These differences make it difficult for the authors to see why the Home Depot case is more persuasive than is either Asper or Leclerc.

C.                 Factual Concerns

Even if it were otherwise appropriate for there to be a due diligence defence available, in the view of the authors, it would be difficult to make out such defence on the facts of a case such as Douglas.  Nonetheless, the Court held as follows:

[15]         In this case, Mr. Douglas was not cavalier about his income tax obligations. As far as the evidence reveals, he was diligent in his compliance efforts and he acted reasonably, and competently. It was not suggested by the respondent that there was information readily available to Mr. Douglas that would have alerted him to this problem.

However, with all due respect to Her Honour, the authors have great difficulty with this holding.  With respect to the last sentence, the Act itself draws the distinction.  The distinction was not “buried” in a regulation that could not be found without special skills, nor located in an administrative bulletin not easily accessed without professional assistance.  The matter is evident on the face of the Act itself. 
While it is true that the Form itself says that it is to be filed “with your tax return”, the Form is very short (two pages).  Therefore, to fully explain the expectations of the taxing authorities in a variety of circumstances, including the particular scenario of a tax return where no tax would be payable could add significantly to the size and complexity of the form.  Forms should not be more complex than necessary.
The essence of the claim of the taxpayer is not that the taxpayer attempted to comply with his obligations under Income Tax Act.  On the contrary, in past years, the taxpayer had not submitted his tax documentation until well after the applicable deadline.  This implies that the taxpayer knew what the deadline was, and thus knew what his obligations were.  In the view of the authors, the taxpayer’s real complaint was that he was ill-informed as to the consequence of shirking his obligations.  In past years, there had been no real negative consequence to the late filing.  The taxpayer assumed that this treatment of his late filing would continue.  It did not. Rather, the administrative indulgence previously granted in situations such as that involving Mr. Douglas was changed.  This in and of itself is not sufficient to ground a remedy.  Although taken from a different context (notably the law of promissory estoppel in the law of contracts), the case of John Burrows Ltd. v. Subsurface Surveys Ltd.[9], per Justice Ritchie, for the Court, is instructive.  The granting of an indulgence, even on multiple occasions, does not, in and of itself, change the legal relationship between the parties. 
Interestingly, in LeClerc, supra, Tax Court Judge Favreau dealt with the same argument, in the following terms (at para. 18)

[18]         The appellant made an honest mistake because he did not know the consequences of failing to file form T1135 by the due date. The penalty under subsection 162(7) of the Act was imposed correctly, and the due diligence defence is not applicable in this case.

In the view of the authors, not doing what the taxpayer knows he, she or it is expected to do is not a sign of due diligence.  This is not altered by the fact that the taxpayer believes (even on reasonable grounds of analogy) that there will no consequences to the taxpayer.  Due diligence is concerned with the actions of the taxpayer.  In this case, Douglas took none.  The law determines the consequences of that inaction.  In this case, Douglas made an assumption that his lack of diligence in filing his tax returns would have no negative consequences for him.  He was wrong.  In the view of the authors, the taxpayer’s mistaken assumption is neither diligence, nor a substitute for it.  As mentioned above, a bona fide attempt to comply on time is

D.                 Policy Considerations

1.                  Parliamentary Supremacy

There can be little doubt that there can be significant disagreement about the appropriateness of the application of this penalty to a situation where there is no income from the foreign property, and that, therefore, the tax return to which Form T1135 is supposed to be appended is not required to be filed in a timely way, or perhaps more accurately, there is no negative consequence for the taxpayer with respect to the late filing of the tax return.  Therefore, the penalty for the late filing of a Form T1135 seems incongruous.  The same is true of the fact that the government is charging a penalty where no unpaid tax is necessarily at issue, that is, there is not a direct financial loss to the public purse.  In Leclerc, Tax Court Judge Favreau wrote as follows:

[20]         It is not so much being subject to the penalty under subsection 162(7) of the Act that poses the problem as the lack of statutory provisions setting out a defence that does not require you to use a program that was not designed to deal with a simple late filing of a form. That is obviously a matter for Parliament. The same observation could be made with respect to the quantum of the penalty; Parliament could consider providing relief to take into account cases similar to the appellant's where the penalty is disproportionate to the tax otherwise payable.

In the view of the authors, everyone (the Asper companies, Mr. Leclerc, Mr. Douglas, the judges involved and the taxing authorities) seems to accept that the penalty provided for under subsection 162(7) of the Act is meant to be strict.  As Tax Court Judge Favreau points out in Leclerc, there are no problems of interpretation in the section (para. n).  In the view of the authors, this is accurate.  Each of the taxpayers involved sought relief from the consequences of the late filing.  It is one thing for judges to point out to the legislature the potentially undesirable effects that a particular provision are having.  In the view of the authors, it is quite another for the court to appropriate to itself the ability to countermand the directive of the legislature.  There is undoubtedly a degree of statutory construction in this exercise.  But, the Court acknowledges (i) the strict nature of the penalty and (ii) that Parliament could have provided for a due diligence defence and did not do so.  Therefore, this is not construction of the statute; this is judicial alteration of its express, and therefore, ignorance of the will of the legislature.  In the view of the authors, this cannot be countenanced.

2.                  Parliamentary Purpose

In the view of the authors, at least one of the reasons that these issues have developed is the distinction between a tax return where no tax is owed, on the one hand, and a Form T1135, on the other.  In the former situation, the Act is explicit that the penalty by virtue of the tax owing on the filing date (subsection 162(1)).  But this is only with respect to a “return of income” for a taxation year.  Subsection 162(7) applies to an “information return”.  The two are therefore intended to be treated differently.  This, of course, leads to the question as to why this is so.  In the view of the authors, subsection 162(2.1) helps illuminate this issue.  The text of the subsection reads as follows:

(2.1)        Notwithstanding subsections (1) and (2), if a non-resident corporation is liable to a penalty under subsection (1) or (2) for failure to file a return of income for a taxation year, the amount of the penalty is the greater of

(a)           the amount computed under subsection (1) or (2), as the case may be, and
(b)           an amount equal to the greater of

(i) $100, and
(ii) $25 times the number of days, not exceeding 100, from the day on which the return was required to be filed to the day on which the return is filed.

Clearly, then, for a non-resident corporation, the penalty for the failure to file on time is determined by both (i) the amount of tax due and payable; and (ii) the lateness of the performance of the filing obligation.  Why would this be so?  The Income Tax Act clearly treats non-residents differently than it does residents of this country, both in terms of their substantive obligations to tax (in terms of for example the availability of deductions), and their reporting obligations. 

When it comes to the latter, in the view of the authors, this is quite logical.  With respect to residents and their property within Canada, information may be obtained from a variety of sources.  Municipal tax records and provincial records with respect to land transfers (and other major purchases, such as motor vehicles) come to mind in this regard.  Similar records for foreign jurisdictions are not as easily accessible by Canadian authorities, if they exist at all.  Therefore, there must be a significant incentive for the major source of information with respect to the foreign assets to make full disclosure.  The major source is the taxpayer him- or herself. 

Given that in all three of the cases referred under subsection 162(7) were situations where no tax revenue was lost, are there other practical reasons why the penalty would need to be a possibility?  The concept of “out of sight, out of mind” is one potential reason.  By definition, the subsection is concerned with residents.  Residents spend more than half their time in Canada.  Yet, the property at issue is both high in value and elsewhere.  Many people have a tendency not to focus attention on material that they do not use on a regular basis.  It is unsurprising that the government decided to make reporting an annual requirement, regardless of the income produced by the property at issue.  By regular reporting, “out of sight, out of mind” is less likely to occur.  To make reporting truly regular in this sense, the need to report has to be independent of the income earned by the taxpayer, either from the foreign property or otherwise.

3.                  Duly Diligent in a Non-Filing?

As mentioned above, it is very difficult for the authors to accept the idea that a lack of action on the part of the taxpayer is a show of due diligence.  As a general rule, diligence requires active participation in the activity concerned.  In Soper v. Canada, [1998] 1 F.C. 124 (C.A.), Justice Robertson considered the use of the due diligence defence found subsection 227.1(3) of the Income Tax Act.  The section deals with the liability of corporate directors for the making of remittances of source deductions from the wages of employees.  In the case, a company, RBI, did not make its source deduction remittances.  Soper was an experienced businessman.  He claimed that there was a “conspiracy of silence” to avoid his learning of the fact that remittances were not being made (para. 58).  The Court held that Soper was aware of financial difficulties for RBI.  Therefore, this knowledge meant as a director, Soper was under an obligation to ask about whether remittances were being made.  In other words, diligence required that the director not make an assumption in the face of cause for concern, but to take an active role in ensuring that the obligation is met. 
It is true that parts of the decision in Soper  were questioned in the case of Peoples Department Stores Inc. v. Wise, [2004] 3 SCR 461.  Nonetheless, the principles referred to were not questioned.  In fact, the main point of contention in the Supreme Court of Canada was whether there was a subjective component in the due diligence defence.  The Federal Court of Appeal was of the view that there was a degree of subjectivity; the Supreme Court of Canada that the standard entirely objective under the duty of care for corporate directors (which used the same wording as the due diligence defence under subsection 227.1(3)).  If anything, the lack of a subjective element makes the due diligence harder to use than provided for in the Federal Court of Appeal’s decision in Soper.

In the view of the authors, even to the extent that a due diligence defence should be read into subsection 162(7), the judicially created due diligence defence should be no less rigorous than its statutory counterpart within the same statutory framework.  In other words, Mr. Soper could not rely on the due diligence defence because he was not active enough in light of what his knowledge.  In the same way, Mr. Douglas knew that he had significant foreign property.  In light of this knowledge, doing nothing with respect to reporting the significant foreign property to the government is not duly diligent on the part of Mr. Douglas.

CONCLUSION

In the end, the authors believe that it is problematic to imply a due diligence defence where the Court acknowledges that the intention of Parliament was to the contrary.  Such an approach is in the view of the contrary to the prior case law that considers the imposition of penalties under subsection 162(7).  Complete inaction by the taxpayer will rarely be duly diligent.  This view is also consistent the approach take to the statutory due diligence defence within the Income Tax Act.  Finally, the need for information from the taxpayer makes the imposition of the penalty a meaningful incentive for the taxpayer to be forthcoming about his or her significant foreign property.  This serves a legitimate practical purpose, and the decision of Tax Judge Woods in Douglas undermines this purpose to an extent.  Therefore, in the view of the authors, the decision in Douglas is highly questionable.


* TaxChambers Toronto, Ontario
** Associate Professor, Faculty of Law, University of Manitoba, Winnipeg, Manitoba.
[1] RSC 1985, c 1 (5th Supp)
[2]The cost amount is defined in subsection 248(1) as the cost based.  It is not the fair market value of the asset.  For new immigrants to Canada, the cost amount is equal to the fair market value of the property at time of entry into Canada.

[3]See  Para. 48 of McClarty Family Trust, 2012 TCC 80

[4] Section 18.28 of the Tax Court of Canada Act R.S.C., 1985, c. T-2

[5] As will be seen in the case law section below, this is not in fact technically correct.  Prior to the formation of the Tax Court of Canada, the Tax Appeal Board was the initial level of appeal for decisions of the various predecessors of what is now known as the Canada Revenue Agency.  From the Tax Appeal Board, an appeal was available to what was then known as the Federal Court, Trial Division (now the Federal Court of Canada).  Currently, an appeal lies from the Tax Court of Canada to the Federal Court of Appeal.  Therefore, currently, there is no direct appeal from the Tax Court of Canada to the Federal Court of Canada.  Nonetheless, due to this historical reality, the Federal Court is viewed in some quarters as being above the Tax Court of Canada.  However, beyond this short explanation, the authors will not focus on this distinction.
[6] On this point, please see Sunita Doobay and Darcy L. MacPherson, “Craig and Stare DecisisCanadian Tax Highlights, (a publication of the Canadian Tax Foundation) Volume 20, No. 2 (February, 2012), at 2-3 and Sunita Doobay and Darcy L. MacPherson, “Gunn & Craig – Hobbies, Farms and Stare Decisis” (TaxNetPro and The Tax Practitioners’ Forum, January 2012) at 1.
[7] 2010 DTC 5154, [2010] FCJ No. 1174, 2010 FC 894
[8] 2009 TCC 281
[9] [1968] S.C.R. 507